Why would someone pay hard-earned dollars for a share of a company?

When you buy a stock, you lay a claim on the future earnings on that stock. You effectively “own” the future earnings of the company. Let’s consider the broad market index today. The S&P 500 companies are expected to earn $70.20 this year. The S&P 500 index closed at 1181.21 today. If someone buys a share of S&P 500 at $1181.21 today, this person is expected to earn $70.20 dollars in 2005 on the $1181.21 investment.

It is widely known that earnings growth for the S&P 500 in last 70-75 years has been around 5%. If earnings grow by 5% in 2006 from 2005 levels, then this S&P 500 stockholder will earn $73.71 in 2006 from the investment. Let’s continue this further: 2007 earnings should be $77.40, 2008 earnings should be $81.27,…………..

The table below lays out the estimated earnings for the next 20 years. Our S&P 500 stockholder owns these earnings as long as she does not sell her stock.

Calendar Year | S&P 500 Expected Annual Earnings | Estimated Fair Market Value |

2005 | $70.20 | 1053.00 |

2006 | $73.21 | 1105.65 |

2007 | $77.40 | 1160.93 |

2008 | $81.27 | 1218.98 |

2009 | $85.33 | 1279.93 |

2010 | $89.59 | 1343.92 |

2011 | $94.07 | 1411.12 |

2012 | $98.78 | 1481.68 |

2013 | $103.72 | 1555.76 |

2014 | $108.90 | 1633.55 |

2015 | $114.35 | 1715.23 |

2016 | $120.07 | 1800.99 |

2017 | $126.07 | 1891.04 |

2018 | $132.37 | 1985.59 |

2019 | $138.99 | 2084.87 |

2020 | $145.94 | 2189.11 |

2021 | $153.24 | 2298.57 |

2022 | $160.90 | 2413.50 |

2023 | $168.94 | 2534.17 |

2024 | $177.39 | 2660.88 |

Total | $2321.23 | - |

In the 20th year of her investment (in 2024), she should earn $177.39. As the final total in the above table indicates, her total earnings from her owning this stock for 20 years should be $2321.23.

Let’s suppose at that time, in 2024, our investor decides to sell her stock of S&P 500. Assuming the normal valuations at that time, she should be able to sell her one stock for 15 times the earnings. That is, if S&P 500 stock is expected to earn $177.39 in 2024 then it should sell for $2660.88 ($177.39*15 = $2660.88).

What is the total reward by owning the S&P 500 stock for 20 years?

Total Reward = Total Earnings + (Final Price – Initial Price)

= $2321.23 + ($2660.88 – $1181.21)

= $3800.90

We did not re-invest the earnings in this calculation. If the earnings are re-invested in the stock, then the “Total Reward” should be much higher than $3800.90.

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